A securities trading mechanism can be thought of as a set of protocols that translate the investors' latent demands into realized prices and quantities. The trading mechanism employed at market opening represents the first opportunity to trade after the overnight or weekend non-trading period. Market openings are often characterized by uncertainty over fundamentals, such as share volume and price, and the presence of multiple potential trading parties. For this reason, opening protocols play an especially important role in facilitating “price discovery,” or the price which will maximize the number of trades at the resumption of trading in securities markets.
The closing or halting of trading on securities markets also is important because closing stock prices are widely used as benchmarks of the securities' values. Portfolio returns and mutual fund net asset values are computed using closing prices. Additionally, after-hours trading on various alternative trading systems (“ATS”) and electronic communications networks (“ECNs”) are based on prices of stocks at closing. Thus, large trading volumes often occur near the end of the trading day which has led to concerns regarding price stability and the ability of the markets to provide adequate liquidity.
Thus, it is desirable to have a method or system for facilitating price discovery and providing liquidity in securities markets at the opening and closing of trading as well as during the course of trading throughout the day.
Securities markets have recognized a need to use special protocols to open trading at the start of the day or following periods of non-trading, or to close trading at the end of the day. Opening protocols employed in some securities markets play an especially important role in facilitating price discovery following the enforced trading halt induced by the overnight or weekend non-trading period. Thus, various attempts have been made by markets to introduce special opening procedures designed to provide traders with information regarding market clearing prices with a view towards enhancing liquidity and reducing intra-day price volatility.
The protocols employed vary greatly in significant ways. By way of example, some markets, such as the New York Stock Exchange (“NYSE”) are intermediated and rely on designated dealers, market makers and specialists, to select opening prices. Other markets simply rely on accumulated overnight public limit orders to calculate mathematically an equilibrium price at which to open trading. Markets also vary widely with respect to the amount of transparency they provide to investors. For example, in the Paris Bourse, traders obtain a sequence of indicated prices prior to the opening which reflects the current market clearing prices, and are allowed to revise their orders based upon this information. In other markets, only limited pre-open price and volume information can be observed at the time orders are submitted.
Most securities markets, with the notable exception of Nasdaq, therefore use special protocols such as single-price batch auctions to open and close their markets. Similarly, single-price auctions are often used as the blueprint for new, automated trading systems such as that disclosed by U.S. Pat. No. 5,873,071 to Ferstenberg et al. and the system in use by the Arizona Stock Exchange (“AZX”). The prior art approaches employed during market openings and closings, and the protocols followed during batch auctions in general vary significantly.
On the NYSE, special protocols apply to the market opening each morning and following periods of suspended trading. As depicted in FIG. 1, the NYSE conducts an “intermediated open” whereby market orders 1 and limit orders 2 accumulate in the limit order book 3 overnight and are reviewed by an intermediary, the specialist, prior to opening. The specialist then uses his or her knowledge regarding the order book and market conditions to set or stabilize security opening price 6 by offsetting large trade imbalances (by personally buying or selling or allowing other floor traders to buy or sell the security as necessary). This system has the inherent drawback in that the specialist has goals which work against accurate price discovery: to provide price continuity, and to maintain a desired inventory of the security. Thus, the price at opening often does not accurately reflect the price dictated by market supply and demand.
The Nasdaq, conversely, currently employs no differentiated opening protocol. During a period prior to the opening of continuous trading on the Nasdaq, market makers and ECNs can enter non-binding price quotes which are broadcast to market subscribers. Although these quotes can be modified at any time prior to the open, they are made to provide a mechanism for dealers to share information and coordinate their pricing decisions. These quotes, however, are at no point binding such that the market makers are under no obligation to execute trades at the quoted price. There are a number of related drawbacks to such a non-differentiated opening. First, there is significant price volatility as accumulated overnight orders are executed in an uncoordinated burst in the first few minutes after the start of trading. This volatility in turn provides an increased potential for price manipulation.
The Paris Bourse and Toronto Stock Exchange (“TSE”) operate as continuous limit order markets. The TSE, unlike Paris, employs a designated intermediary, termed the Registered Trader, for each stock who is responsible for maintaining the limit order book. The TSE is transparent as it displays the order book and disseminates an indicated price, the calculated opening price (“COP”), based upon current system orders. The COP is continuously updated based upon new orders and fluctuations in relative supply and demand. To discourage gaming by traders the TSE has implemented anti-scooping rules whereby non-client orders entered within the final two minutes before opening are figured into the COP, and thus guaranteed a fill at the COP, only if they impact the COP. Non-client orders not impacting the COP are not guaranteed a fill at the COP, and are automatically treated by the TSE as the equivalent of a limit order having a price equal to the COP. In the event that there is a “guaranteed fill imbalance” (not all guaranteed orders can be filled by matching orders due to order imbalance), the Registered Trader is required to either provide the requisite liquidity at the COP, or to delay the opening until sufficient orders offsetting the imbalance enters the TSE. Additionally, orders having a price equal to the COP (such as a market order) are allocated executed shares only after all market orders and orders having prices better than the COP are filled. Thus, the priority and allocation rules of the TSE system gives it the inherent drawback in that limit orders at a price equal to the COP can get frozen out of the trading process and are not treated the same as market orders and better priced limit orders. Furthermore, if there are no intersecting limit orders for a particular security, no COP is calculated and no limit orders are executed.
In the Paris Bourse, a similar batch auction system is employed except that traders can observe the limit order book away from the current price. This high degree of transparency allows traders to assess the likely impact on the opening price of new orders, but similarly encourages gaming as orders may be readily canceled up to the open. Furthermore, there is no designated intermediary to provide liquidity when there is an order imbalance. The Paris Bourse also has introduced a closing call auction using similar priority, cancellation, and transparency parameters. This system suffers from several drawbacks, including: significant gaming incentives, price instability, and no guaranteed liquidity.
The Arizona Stock Exchange (“AZX”) operates solely in a batch auction market format. Thus, its open (the first trade of the day) and its close (the last trade) do not have protocols which differ from other trades during the day. Like the Paris Bourse, the AZX has a high degree of transparency in that traders are permitted to see the entire order book prior to an auction and can view beforehand the exact price at which trades would occur. This again leads to gaming which prevents accurate price formation.
The OptiMark electronic trading system employed by the Pacific Stock Exchange (“PSE”) conducts repeated batch auctions over the course of a market day similar in manner to the AZX, but offers less transparency and generates multiple prices such that all trades of a particular stock during a given auction are not made at the same price.
U.S. Pat. No. 5,950,176 to Keiser et al. discloses an electronic securities trading system which uses a computer program to project price movement of securities and set suggested prices for trading in continuous trading markets. This system does not solve the problems attendant in batch auction methods and systems where providing optimal price determination is hampered by gaming and low liquidity.
The prior art approaches to using batch auctions at the open and close of a financial market, as well as repeatedly throughout the market day along with continuous trading, have encountered numerous drawbacks. Open order books combined with lack of restrictions on the message space prior to the open introduce gaming problems, for example as experienced by traders in the Paris Bourse. The existence of multiple order books with different levels of transparency and different execution priority rules, as used by the AZX, produce undesirable disparities in fill rates. An additional drawback is that simple batch auction design is not sufficient to produce accurate pricing in low liquidity, high volatility markets as is present for thinly traded stocks. Further, intermediated exchanges depending upon human intervention, such as by specialists on the NYSE and TSE, introduce exterior forces upon market price determination, such as the specialists' inventory concerns. Additionally, price discrimination among traders within a single auction based upon their order types, as done by the PSE OptiMark system, can cause dissatisfaction among participating traders with the outcome produced by the auction system.
Due to the above mentioned and other drawbacks, there remains a need in the art for improved methods and systems to conduct batch auctions of financial securities in financial markets, particularly both following and preceding periods of trade stoppage or inactivity.